From rogue traders to hedge fund failures, Ponzi schemes to Madoff, it is little wonder that operational due diligence (ODD) has become such a vital component of the asset management industry. And with regulatory obligations only set to increase in the very near future, these evaluations will play a key role in improving transparency and accountability across the sector from investment managers to their investors. Yet, as many funds are still overly reliant on manual processes, such as the use of spreadsheets to monitor their portfolio risk, they really do need to adopt a more audit focused solutions instead.

Setting the standard with Open Protocol

These evaluations primarily exist to protect investors, ensuring all proper controls are in place and evaluating the fund’s portfolio risk. This has led to a growing push for greater adoption of the Open Protocol standard. Developed in 2011 in a bid to improve fund transparency and help investors aggregate their exposure, the Open Protocol template is a way of evaluating a fund’s portfolio risk and reporting that information in a standardised fashion. Open Protocol covers all major asset classes with counterparty risk and investor breakdown. It is structured in 3 Grades such that managers can provide the information at different levels of granularity (depending on their preference/comfort level). In May, the Hedge Fund Standards Board (HFSB) took on the role of co-chairing the Open Protocol Working Group alongside Albourne Partners, so the increased importance in the industry is clear.

However, if you’re a firm that has been historically receiving investments from family offices or other non-large institutional investors, you may not have needed a rating from an evaluator such as Albourne, Aksia or Cliffwater at all. But if you’re going to raise institutional money—such as pension funds, endowments etc., then these types of investors now typically require you to have a rating. And while a rating evaluates how strong a fund is, Open Protocol calculates and reports the findings. For example, Open Protocol might examine the Value-at-Risk (VaR) for the portfolio sensitivity to market changes, and stress tests for various scenarios, including catastrophic events.

Spotting dangers

Even if Open Protocol is not yet a regulatory requirement for your jurisdiction, it is likely to still be very high on your investors’ wish lists. By adopting an automated solution for the portfolio risk component of ODD, you can also ensure this is achieved in a secure, efficient and cost effective way. For example, AQMetrics’ technology can provide Open Protocol reporting for your risk analytics. Additionally, we can enable alerts and automated reporting at the operational analyst level. You can then translate that information and put it out to board reporting, or you could put it out to investors for operational due diligence, helping you complete yet more pieces of your compliance puzzle.

We expect the Open Protocol to become increasingly adopted among investment firms, as the need for standards around evaluation of portfolio risks evolve.